The liquidity problems of Chinese real estate giant Evergrande triggered panic in international markets, fearing that the collapse of China’s second largest real estate developer could trigger a domino effect in the housing market and impact international markets.
Evergrande’s situation is critical, as its total liabilities are equivalent to 2% of China’s GDP, yet Beijing has given no sign that it is willing to give a financial bailout to the real estate colossus that has less than $15 billion.
For years, Evergrande relied on the easy credit granted by commercial banks and other investors in exchange for the delivery of bonds rated as “junk” by the American risk rating agencies, which, in order to be accepted in the market, paid up to double-digit interest rates.
As China was experiencing a housing boom, companies such as Evergrande incurred massive amounts of debt to finance their projects, confident that the liquidity from the payment of millions of Chinese families would be sufficient to pay creditors.
With the introduction of new financial regulations for real estate companies, high debt schemes with little liquidity will be regulated more harshly, and in the particular case of Evergrande, the company was legally unable to take on more debt and has been left without the liquidity to finish building its projects and has had to pay its suppliers with real estate.
Although Evergrande has considerable assets in the form of thousands of homes, this is not an easily monetized asset and it is not clear that creditors are willing to receive apartments as payment, and then have to find a buyer for them and finally obtain the cash.
At the moment, Evergande is in a debt restructuring process with Chinese creditors, to whom it was to pay almost $50 million in interest, a payment it defaulted on. Debt restructuring, according to Li Kai of Shengao Investments, “usually involves an extension, term payments or reduction of the interest coupon on the debt,” he explained.
Although for the time being, Evergrande has managed to reach a payment agreement with China’s main government-controlled commercial banks and local investors, foreign creditors are still waiting for its payment of more than $83.5 million for the month of September, and credit agencies are warning of a complete default by the Chinese real estate company. During the remainder of the year Evergrande will have to pay $669 million in interest alone.
As financial analyst Wolf Ritchier explains, China has mechanisms that a democracy does not have, such as the control of the main commercial banks, a Central Bank at the mercy of the Government, and a stock market regulated according to the interests of the Communist Party.
Although Beijing has given no indication that it will bail out Evergrande with government money, the truth is that Xi Jingpin’s regime, the last thing it wants is for the giant to collapse and for Chinese creditors to lose their money, as well as for thousands of homes (which today Evergrande owns) to be put up for sale at below-market prices in order to pay off the company’s debts quickly.
Hundreds of thousands of homes for sale at a lower market price, due to the size of Evergrande’s assets, would lead to the collapse of housing prices in China. Something that would be catastrophic for millions of families, as real estate is their main or even only investment.
In a period of ten years household debt in China has gone from representing 18% of GDP to just over 60%, taking into account that much of this debt is housing loans, a fall in the price of real estate would jeopardize the stability of the Chinese credit system, which like the American in 2008 was confident that the price of housing would continue to rise.